IMF chides Turkey on reckless policies as taper looms

The International Monetary Fund has told Turkey to tighten policy without
delay to control a ballooning trade deficit, warning that the country is a
prime candidate for capital flight as the US Federal Reserve starts to
withdraw global liquidity.

“The authorities’ immediate priority should be to reduce imbalances,” said the Fund in an unusually blunt report, criticising the Islamist government of RecepTayyip Erdogan for sailing dangerously close to the wind.

The IMF said surging imports will push the current account deficit to 7pc of GDP this year, far above safe levels at time when the Fed and other G10 central banks are starting to tighten monetary policy.

“The market reappraisal of advanced economies’ monetary policies has exposed Turkey’s main vulnerability — its external imbalance. A weakening or a reversal of capital flows present a major challenge,” said the report. The IMF said the government must rein in spending to cool overheating and abandon hopes for growth of 4pc to 5pc a year.

It is an unwelcome message for Mr Erdogan as he prepares for elections in March and struggles to shore up his popularity after crushing this summer’s Gezi Park protests by force with live ammunition. Amnesty International accused the government of human rights violations on a “huge scale” in the crackdown, which left 8,000 injured and three dead. The clash laid bare the deep divisions been in Turkish society as Mr Erdogan tries to dismantle the secular state dating back to Kemal Ataturk.

The IMF’s harshest rebuke was reserved for the central bank, which has burned 15pc of Turkey’s foreign reserves trying to defend the currency since the emerging market squall began in May.

The Fund said the “immediate priority” is to raise interest rates – still negative in real terms – to restore investor confidence and choke off excess credit growth. “Foreign exchange rate interventions cannot substitute for the right monetary stance,” it said.

The warnings come as the high priests of global finance gather for the IMF’s annual meeting in Washington this week, an event that kicks off with a forum on emerging market travails.

The Fed’s decision last month to delay the “tapering” of bond purchases has bought time for the so-called “fragile five” with big current account deficits – India, Turkey, Brazil, Indonesia, and South Africa (though Ukraine, Serbia, and others are equally at risk). Christine Lagarde, the IMF’s chief, has warned repeatedly that emerging markets are not yet out of the woods, reminding the Fed it has a duty of care to unwind quantitative easing (QE) in an “orderly way”.

Roughly $4 trillion (£2.5 trillion) has leaked into emerging markets since the rich world began printing money on an epic scale. Only a tiny fraction of this has flowed back out again so far. IMF officials fear this could accelerate abruptly once tapering starts in earnest.

Turkey has been a star performer over the past decade but serious problems have been building up. Capital Economics said the country is now among the most vulnerable of the emerging market economies, citing an external deficit “funded almost entirely by short-term, and potentially volatile, portfolio inflows and borrowing from banks abroad”.

While public debt has fallen to 36pc of GDP this can be deceptive at the top of the cycle. Spain and Ireland also looked invulnearble until they were toppled by the excesses of their banks and developers.

The external debt of the banks has risen from 8pc to 14pc of GDP, the highest in 20 years. Two thirds of the loans have to be refinanced over the next year.

Patrick Legland from Societe Generale said Turkey's net international investment position (NIIP) has plummeted to minus 60pc of GDP, well below the safe threshold of 35pc for emerging markets. "The Turkish lira remains at risk as the Fed exits QE in 2014," he said.

Mr Erdogan appears defiant for now, convinced that the storm has passed, and reassured that Turkish companies were able to roll over loans in August and September.

"The fear is gone for now. Policymakers do not see any reason in the short term to address Turkey's external imbalances, "said Turker Hamzaoglu from Bank of America.